Charlie Munger, the 99-year-old billionaire and vice chairman of Berkshire Hathaway Inc., expressed his concerns about the United States heading toward another fiscal crisis. In an interview with the Financial Times, Munger highlighted the problematic situation of commercial property loans held by U.S. banks, stating that many of them would be deemed as “bad loans” because of declining property values. He emphasized that this indicates a negative outcome for the American commercial property market.
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“It's not nearly as bad as it was in 2008,” Munger said, acknowledging that the fallout from the bursting of the bubble should not be as catastrophic as the 2008 collapse.
But he cautioned that trouble can happen to banking, just like it can happen everywhere else. During good times, bad habits can develop, and when bad times come, banks can suffer significant losses. Major losses can result in a credit crunch that consequently triggers a chain reaction across the economy, potentially resulting in a recession.
Munger reflected on the severe contraction in the U.S. housing market over the past year, noting that a lot of real estate isn’t as valuable as it used to be. Troubled office buildings, shopping centers and other properties are prevalent, causing considerable agony in the market.
He further observed that banks across the country have tightened their lending practices concerning real estate loans. “Every bank in the country is way tighter on real estate loans today than they were six months ago,” Munger said. He also mentioned recent turbulence in the U.S. banking system, citing the closures, bailouts and near-collapse of Silicon Valley Bank, Signature Bank and First Republic Bank, which have contributed to a crisis of confidence.
Considering his extensive experience alongside Warren Buffett, Berkshire’s CEO, Munger anticipates that banks will face challenges with their commercial real estate portfolios because of the decline in property values and the rise in office vacancies. Nevertheless, he believes that these roadblocks will be milder compared to the Great Recession of 2008.
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Contrary to the memories of the 2008 financial crisis, where foreclosure signs were widespread and the housing market crumbled, a potential downturn in 2023 would likely unfold differently.
One crucial distinction between the current housing market and that of 2008 lies in the health of its underlying fundamentals. Before the Great Recession, banks extended credit easily to borrowers who were not adequately qualified, fueling risky subprime mortgages. Oversight was lax, leading to a housing bubble that eventually burst, leaving financial institutions and investors saddled with trillions of dollars in worthless mortgages and mortgage-backed securities.
Although Munger voiced his concerns regarding commercial real estate, the residential housing market is not in the same boat. Despite the Federal Reserve continually raising interest rates to combat inflation, the value of homes hasn’t dramatically declined. Foreclosures are still uncommon.
The surge in housing prices during 2021 can be attributed to a distinct set of factors that do not resemble a bubble. Several factors contributed to this trend, including a restricted growth in the housing supply available for sale, a rising proportion of individuals ages 25 to 40 who traditionally purchase homes, a robust economy and a slight relaxation in lending standards for creditworthy borrowers.
Berkshire Hathaway, known for its investment in banks, including Goldman Sachs and Bank of America, has supported the sector during previous financial problems. Munger acknowledged the difficulties of running a bank, stating, “It's not that damned easy to run a bank intelligently, there are a lot of temptations to do the wrong thing.”
Despite Berkshire’s long-standing investments in insurance companies, neither Munger nor Buffett favors the volatility associated with loans in commercial real estate. Munger pointed out that the decline in property values, particularly in office buildings and shopping centers, is unlikely to see a turnaround soon, especially as remote work continues to be prevalent. To mitigate risk, some banks have already started approving fewer commercial real estate loans.
Investing in a Turbulent Market
The Berkshire Hathaway legends have a lot to say when it comes to investing, especially during a downturn. Buffett’s famous quote, “be fearful when others are greedy, and be greedy when others are fearful” is a lynchpin saying of the Oracle of Omaha. Ultimately, there are many strategies to investing during the downturn, but Buffett tends to boil it down to the same strategy he uses for investing during normal market conditions: find valuable companies are depressed valuations and hold for the long term. It’s just a bit easier when everything is down.
The startups market tends to see compressed valuations when the stock market declines. As valuation multiples compress in the public markets, those translate to declines in the private markets. This means there might be opportunities for investors in startups on platforms like StartEngine, which allow anyone to invest in startups.
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